Research Articles Base: Financial

FINANCIAL MANAGEMENT: CALCULATION

1a 　 Year 　 (1) Cash Flow (million $) (2) Tax (25%) (1) – (2) = (3) After Tax Cash Flow (million $) (4) Discount Factor @ 7% (3) x (4) Present Value (million $) 0 -12.0 -　 -　 -　 -12.000 1 5.5 1.375 4.125 0.93458 3.855 2 6.5 1.625 4.875 0.87344 4.258 3 7.0 1.750 5.250 0.81630 4.286 Scrap Value 2.0 -　 2.000 0.81630 1.633 　 　 　 　 NPV = 2.032             Discount factor (Real rate) = [(1 + normal rate) / (1 + inflation rate)] – 1       = [(1 + 12.5%) / (1 + 5.1%)] – 1         = (1.125 / 1.051) – 1         = 1.07           = 0.07           = 7%       NPV of the project is .232 million.             2a TSR = [Dividend + Capital Gain] / Opening share price, expressed a percentage   Capital Gain = (share price at the end of period – share price at the begin of period)   TSR = {[.5 + (.71 - .58)] / 4.58} x 100   = {(.5 + .13) / 4.58} x 100     = {.63 / .58} x 100     = 0.574 x 100       = 57.4%       Credit:ivythesis.typepad.com

FINANCIAL MANAGEMENT: CALCULATION

1a 　 Year 　 (1) Cash Flow (million $) (2) Tax (25%) (1) – (2) = (3) After Tax Cash F...

APPLIED FINANCIAL SKILLS: ANALYSIS OF APPLE COMPUTERS INCORPORATED

FINANCING AND PROJECT APPRAISAL ALTERNATIVES: ANALYSIS OF APPLE COMPUTERS INCORPORATED   Table of Contents                                                                        Page Summary                                                                                          1 Introduction                                                                                       Fundamental Risks of the Business                               2 Research Methods                                                                          3 Body of Analysis             Sources of Financing                                                         4          Methods for Project Appraisal                                           7                      Conclusion                                                                                       11 Bibliography                                                                                     12   Summary             This presentation is about Apple and how it could use available financing and project appraising alternatives to its advantage.  The first section introduces the position of Apple relative to existing risks followed by discussion on how the information in this paper is organized and analyzed.  The following section is the body that shows evaluations of different financing options available to Apple and how each benefit or risks the position of Apple based on its current risks.  IN addition, project appraisal methods are also treated on the same way as financing.  As a conclusion, Apple must not depend on a singular financing option because mixture of financing alternatives would provide the optimal capital structure while project appraisal techniques must be integrated.    Introduction Fundamental Risks of the Business The first consideration is the business risk that Apple confronts such as stagnation of its innovative structure and changes of leadership mindset and/ or abrupt changes of the leader itself.  The latter issues are reflected by the decision of the firm to include to its portfolio non-high end markets and the health issues attached to Steven Jobs.  Due to this, variances on earnings and increased investment risks had developed.  In the contrary, Apple’s strategic re-utilization of existing software to create new set of technologies minimizes financial risk because resources are recycled.  Alternatively, equity-based partnering to other companies and support from government authorities in research efforts of hi-tech firms ultimately diminishes leverage s issues.     High-tech firms are characterized by lower liquidity as most of their assets are tied-up with R&D efforts where their value is hard to estimate and is highly illiquid.  To minimize liquidity risks, Apple assures that short-term assets have reduced maturity while long-term assets are applied with limits.  Although the framework may not bear additional inflows from interest-bearing long-run investments, assets are relatively more transferable to cash equivalents.  In addition, cross-border trades of Apple with emerging economies are applied with substantial spot exchange risks which can reduce price competitiveness.  To resolve the issue, Apple enters futures/ forward contracts in the derivative market to address risks in fluctuations in exchange rates and interest rates.   As Apple is operating in difference political/ economic environments, its expansion and success is highly dependent on the level of support that governments provide to multinationals.  This admonitions is concretized by the fact that Apple outsourcers, communicates and transacts with different global participants to complete its supply and value chains.  As they are uncontrollable, political risks can be minimized by specialized insurance in which undoubtedly kept by big companies such as Apple.  Lastly, credit risks are not really attached to Apple mainstream financial framework.  Its distributors carry the substantial amount of debt from end-users where collaterals are inexistent.  However, Apple also feels such practice that motivated the firm to create doubtful accounts to distributors depending on their debt history, profit/ growth and credit worthiness.   Research Methods             The data that are presented came from different sources such as journals, textbooks, news articles and online information.  Information is analyzed based on the context of the risk confronting Apple presented in the introduction.  Appropriate models for financing and investment decisions are summarized and highlighted their major differences with other types.  Apple is seen as a case study because the researcher wanted to explore the different implications of certain financing and investment appraisal tactics that can be used by the company.  The analysis is guided by the nature of high-tech industries and the position of Apple to address inherent risks that it confronts.  The data is also carried as desk research due to existence of voluminous information online.        Body of the Analysis Sources of Financing Every form especially those who are listed in capital markets have the privilege to mix different financing sources from varying investors/ creditors from any part of the world.  As for Apple, there are two major types of financing; namely, debt and equity.  The former is defined as the act of raising funds through issuance of bonds while the latter is the act of internal funds.  According to some theories, optimized capital structure can be attained when the cost of using the sources of financing is minimized while the value of the company is maximized.  However, there are also issues of financial risks as high-reliance to debt will result to inability to pay interest obligations or paying the principal.  With this conflicting statement Apple is expected to choose among the most lucrative sources of financing available.    One type of debt financing is seller financing which is characterized by ease of making the contract and Apple can immediately use the assets of the other party (i.e. operating plants). However, the downside is that Apple must comply with continuous amortization to prevent litigation of being incapacitated.  As a result, there is less flexibility that will not be compatible with Apple’s current change in strategy because withdrawal from the contract due to detection of inability to achieve synergy is not an excuse to avoid default.  Government-supported projects are also potential source of financing; however, most of them are for smaller business interests due to lack of access to necessary capital.  Consequently, Apple’s projects are relatively huge and also require substantial financing which may only deter their application as the firm is qualified for worldwide capital market access due to global presence.    Commercial banks are also willing to extend credit to big companies as long as its financing fundamentals and growth prospects are healthy.  This option can provide any requirement for huge financial needs of Apple which in accordance to the level of innovation it requires.  However, there is conflict of interest when transacting with banks because the borrower and the creditor has both with profit-oriented goals.  Specifically, bank requirements and limitations that the borrower must comply (i.e. smaller equity issues) can deter some of financing strategies from Apple.  Also, screening for potential debtors may take a long time which is not strategic and can undermine speed-to-market.  Alternatively, mezzanine financing can be tapped wherein banks will finance the project through less stringent and faster loans, however, with the requirement of ballooning equity interest attributable to banks.  However, this strategy can substantially allocate the cash flows from the project to banks.  As a result, the firm has minimal control over its growth direction. In the contrary, equity financing is usually represented by initial public offerings (IPOs).  As Apple is in its expansion and growth phase, this type of financing has high potential as the proven successes in the selected markets where the firm operates.  IPOs give investors the opportunity to own part of the company through holding stock certificates and entail them to receive returns during profitable operations (i.e. dividends).  The positive feature of IPO is the ability of the firm to grow and execute its plans without interference from the obligations from creditors that can hamper liquidity and disable growth prospects.  Further, investors in stock markets are relatively plenty and more motivated than bond issuers because sock investors can gain on both short and long run periods compared to debt financing where maturity is more on the long-run side.  However, Apple may loose control of the operations, receive hostile bids and being taken away.  As a result, IPOs and succeeding issuances must be supported with rigid ownership planning and financial control.   The last option would be the retained earnings.  As Apple see them as savings after paying debt and equity obligations, it can serve as useful financing mechanism to hedge the negative issues of debt/ equity.  Using retained earnings, Apple can eradicate costs and risks of financing alternatives.  The backside, however, is that the firm must not rely on retained earnings exclusively especially during intense rivalry.  Several firms that actively participated in competition against major industry players ran-out of business because they cannot sustain the financial needs of such engagement.  Undermining the use of debt/ equity mixture in the capital structure may show hostile approach of the firm to the willing creditors and investors.  Investors/ creditors may feel that the use of retained earnings indicates the last stand of the company.  As a result, notices for debt repayment will ensue due to anxiety wherein the competing firm can destabilize its strategy instantly.    As debt financing is cheaper than equity option due to the tax-deductible expenditure feature of the former, it can provide incentives for Apple.  However, Apple will shoulder a commitment to pay without assurance of profit where equity financing can redeem its upper hand.  With the use of equity, bankruptcy and being a target can be prevented.  Debt can also threatened existing stockholders because external creditors are prioritized during asset allocation upon liquidation.  As Apple is not a closed corporation and its shares are heavily traded in capital markets, loose of corporate control will be a small issue to consider compared to the benefits of equity financing which are largely IPOs in nature.  The caution, however, must be applied in evaluating the possibility of unintended takeover from market manipulation.  Due to this, finding the most appropriate capital structure for Apple must be applied with larger investment criteria like supporting theories on optimal capital structure and the nature of the projects it will invest in.  The latter is discussed on the following section.    Methods for Project Appraisal There are available techniques to evaluate the financing relevance of major projects.  This will help Apple management to determine the appropriate capital structure (i.e. debt, equity or retained earnings) for its projects.  First is the technique that highly supports the time value of money principle which is payback period.  This technique adheres to the concept that the money that is received today is less risky and has higher value than the same amount of money that will be received in the future.  Its strength is derived by its simplicity without requiring derivation of future values to current values.  In addition, it is useful in appraising projects from the standpoint of a firm that will be acquired in pre-determined date in the future.  As a result, the firm can optimize its operational existence by focusing on the years where the capital outlay will be recouped and profit will be realized.  However, as it does not conform to present value computations, it diminishes time value of money concept.  It is also regarded as subjective analysis to investment valuation due to substantial intervention of managerial influence for the purpose of accelerating the period of profiting from the project.   A more investor-focused alternative is offered by return on equity (ROE).  This is a financial ratio that indicates how much equity holders are earning.  With existing shareholder in mind, the cost of equity is intended to be reduced while returns of holders are intended to be maximized through dividends or other distributing in assets.  When ROE would increase, it will imply efficient allocation of corporate funds on business areas that are growing.  In the contrary, internal rate of return (IRR) is a more complicated investment measure than ROE.  Its ultimate contribution to decision-making is to assure that the discount rate being used in net present value derivations are really equal to investor’s as well as the project’s expected return.  Comparative analysis is also provided by IRR (i.e. expected return and required return) polishing the return outlook of holders.  In addition, IRR utilizes discount rates in their maximum capacities because they are able to contrast two or more projects.  The drawback is that these projects must have the same operational periods, discount rates, betas (i.e. measure of industry sensitivity) and the requirement that there must be apparent cash flows.     The advantage of using ROE is the comfort of using industry benchmarks. This can provide firms to have a guide in decision-making.  However, ROE is tinted by accounting manipulation in the hope of attracting additional holders.  For example, excessive writer-downs, repurchase of stocks and, even having large debts can increase ROE.  In contrast, IRR can evaluate the costs and benefits of different projects which maximize investment selection process.  As ROE deals with investment projects as a whole, IRR deals with piecemeal and more elaborate underlying of alternatives.  The latter statement is tarnished by the inability of IRR to tackle combined project inflows and outflows of huge investments as it cannot protect its reliability posted by external/ market factors.  Also, getting appropriate discount rate which is the cornerstone of IRR is tedious but with little assumptions necessary to operate IRR the former challenge can be undermined and conclude that IRR is relatively simple investment appraisal compared to highly-acclaimed NPV.                           Net present value (NPV) can rationalized the risks attached to projects which require long-term periods before the payback is achieved.  It is simply the sum of annual cash flows of the entity that is applied with discounting after profit is identified.  Also, non-cash transactions are also brought back to the net income.  In effect, the technique is focused on cash flows rather on financial statements.  NPV is simple such as accept projects with positives NPVs and reject otherwise.  To support identification, NPV tables and supporting data are existent.  In the contrary, NPV does not offer tools to reduce capital outlay which can adversely affect the level of investment.  Due to this, it is tagged as pure analytical framework and is not responsive.  In effect, its effectives can only be obtained if it will be applied with other techniques that identify inefficiencies, value-creation methods, project stoppage and withdrawal for determining opportunities to minimize risks or maximize returns.  NPV can supply the lacking of payback period about time value of money while the IRR’s historic approach  on analyzing data give NPV upper hand in forecasting future returns and basis for sound decision-making.        The appraising framework of Apple could be bias on global operations making cross-border investments a noteworthy consideration.  In this veil, ROE can measure equity and direct investments in host countries in a manner that above average returns are emphasized.  Host companies (i.e. using the industry standard) can imply the nature of investor expectations and can be used by Apple to determine its operational performance to address.  In the contrary, IRR can reduce external risks of the foreign operations (i.e. political, cultural, and economic).  IRR is based on projects that from start-to-end Apple is assured that necessary actions such as to plan, monitor or evaluate performance.  In this veil, ROE and IRR can provide information that are corporate-level and project-level in nature respectively.  As a result, Apple can select between the two who addresses the nature of its risk-tolerance and corporate objectives.  Lastly, NPV can aid in discounting while payback period can inject some valuable inputs from managers that can substantially uplift the credibility of ROE and IRR.   V. Conclusion             It is concluded that the firm will use different sources of financing to obtain optimal capital structure as well as use integrated appraisal framework depending on its current and future strategy.  Partnering as a source of short-term competitive advantage can be lucrative to the high business risk and political risk of Apple particularly in cross-border operations.  Consequently, ROE can be used for these host country operations.  However, NPV and IRR can serve as maximizing tools for Apple to base its investment decision objectively while payback method can also used to give way to experienced decisions of managers.  In the end, the dynamic environment of high-tech firms can change the emphasis of Apple regarding these sources or tools.  But the rule is to align business strategy to the instrument to be utilized.           Bibliography Books Journals   Electronic Sources     Credit:ivythesis.typepad.com

APPLIED FINANCIAL SKILLS: ANALYSIS OF APPLE COMPUTERS INCORPORATED

FINANCING AND PROJECT APPRAISAL ALTERNATIVES: ANALYSIS OF APPLE COMPUTERS INCORPORATED Table of Contents ...

CORPORATE FINANCIAL STRATEGY

“The intuitions gained from the real options approach to capital budgeting are always useful, but the approach is very difficult, if not impossible, to implement.” Discuss, using illustrative examples where appropriate.     Capital Budgeting             Capital budgeting comprises a vital aspect of investment and marketing decisions. Decisions covering investment options involve time in considering the relative expected returns from the various options. Options deemed to lead to low levels of return would be rejected while the investment option offering high rates of return would likely be considered for investment. A requisite in determining the relative rate of return of investment options is the expected maturation period of the investment or the period within which returns are expected to be earned. Examples of investment options for a manufacturing firm include the expansion of the production plant, addition of machines or hiring of new workers due to an expected increase in demand. Decisions involving marketing decision options involve the ways of increasing sales such as boosting advertising campaigns, enhancing the training of sales personnel, or increasing the number of sales personnel. The decision largely depends upon certain measures such as the ratio or sales to advertising that expresses the impact of the enhanced advertising campaign to increase in sales. Although, the impact of advertising on sales is difficult to measure, the ratio serves as an important means of supporting marketing decisions. Throughout the process of investment and marketing decision-making, capital budgeting serves as the means through which the decision is achieved including the laying out of the factors that need to be considered based on business context and actions when certain factors arise.               Capital budgeting also constitutes an important aspect of financial management particularly of capital assets. Even if capital assets constitute only a small component of the total assets of the company relative to current assets, decisions on capital assets involve long term effects. This means that the decision on capital expenditures should be made with care because mistakes would be felt by the firm in the long run. The usual motivation for firms to engage in capital expenditure decision involves expansion, modernisation, replacement or strategy. In order to achieve these goals and avoid mistakes, capital budgeting is used as the encompassing process that involves the generation, evaluation, selection and follow-up of capital expenditure decisions. In recognition of the importance of capital budgeting, business organisations especially large firms develop or adopt approaches in applying the capital budgeting analytical process.   Real Options Approach               (1996) describes the real options approach as the new valuation, strategic decision-making and project management paradigm that addresses the weaknesses of traditional approaches by allowing for flexible decisions amidst uncertainty. This description implies several things about real options approach. First is the status of the approach as an alternative to traditional capital expenditure decision paradigms of Net Present Value (NPV). Net Present Value is a decision-making measure that sets out the difference in the value derived from the capital expenditure relative to the cost through the formula    where: t is time of cash flow; n is total activity time; r is discount rate; Ct is net cash flow (amount of cash) for time t; and C0 is capital outlay at the start of time t. If the NPV value derived is greater than 0 the positive value represent that value added to the business so that the capital expenditure plan should be subject to approval, if the NPV value is equal to 0 implementing the capital expenditure plan would not contribute any gains to the company but there would also be no loss so that the plan will not benefit the firm, and if the NPV value is less than 0 the negative value represents the loss expected to be incurred by the business so that the more that the plan should be scrapped. (,  &  2001) Although deemed as the traditional approach to capital budgeting, NPV is still extensively used. This is because according to  (1996), this approach is the only analytical measure that works with lack of “managerial flexibility” that is “consistent with a firm’s objective of maximizing its shareholder’s wealth” (). However, there are alternative analytical tools that address the weakness of NPV of not including the option of delaying irreversible capital expenditures ( &  1994) because the conclusion of the measure is only whether or not to push through with a plan. Real options approach as an alternative to NPV works by empowering decision-makers to hold the right to proceed with a capital expenditure plan instead of obligating them to make the decision. Real options approach then provides decision-makers with the option to test the waters first before diving head on to open water even if the plan has already achieved a positive NPV value. This is consistent with the recognition of capital budgeting as involving long term effects whether the effect is positive or negative so that the decision-maker needs greater assurance before taking the risk through vigilance over changes in business context or environment or in the capital assets.             Second is the role of the real options approach as a paradigm, pattern or guide for business firms. Applying the real options approach is akin to playing poker. All the players have their money to bet. They lay their ante on the table before the cards are dealt. The traditional approach would urge the players to place or raise their bets if they consider as high the value of their cards and due to the expectations of winnings in the amount of the ante and bets taken together. However, the players are not aware of the value of the other players’ cards, which could be higher or lower so that most of the players would have to part with their money leaving them with nothing. In applying real options approach, players believing that their cards hold a high value are urged to match the highest bet to proceed to the next stage of opening new cards and discarding to obtain new cards to ensure greater assurance of winning. The entire game also involves the process of assessing what the other players are thinking and making a decision based on the value of the cards as well as the perceived or expected action of the other players. In this way, the player either folds due to the knowledge that there is too high a risk involved or plays all out for the win.             Third is the ability of the approach to allow decision-makers flexibility in the decision-making process because of the inevitable intervention of uncertainty so that the decision-maker necessarily have to rely upon intuition. This is again captured by the game of poker. Flexibility amidts uncertainty is also captured in the key concepts of the real options approach.             One key concept is investment defined as the action of having immediate costs with the expectation of future returns ( &  1994). Uncertainty in investment pertains to the risk involved in implementing a capital expenditure plan. However, flexibility arises in applying the real options approach through particular risk-reduction activities such as engaging in research and development to support the viability of a product concept and patenting the product design in order to have exclusive rights to it and incur added value or implementing an introductory promo to determine the reception of the market to an innovative product before actually engaging in mass production. Even if positive returns are expected, decision-makers have the flexibility to alter the capital expenditure plan or deviate from it based on the results of initial testing and intuitive business sense.             This means that the real options approach does not only limit the decision-maker to the isse of whether or not to go through with a capital expenditure plan but also the issues of the ways of achieving the plan, assessment of achievements or performance, and adjustment of the plan directed towards the purpose not only of ensuring returns but also the highest possible returns due to minimised risks and costs ( &  1995).             Another key concept is sunk cost, which pertains to the outlay that has already been committed ( &  1996). The implication of a sunk cost is its irreversibility especially if the capital expenditure uniquely pertains to a company or industry. The areas of advertising and marketing are both company specific so that these involve sunk costs that are irreversible and unrecoverable. Other factors contributing to irreversibility also include the application of government regulations, institution-based arrangements, and coporate culture differences usually experienced by globalising businesses such that capital controls make it selling or reallocation of assets difficult.             Due to the irreversibility of decision applications on capital expenditures, the decision-making process should involve intense analyses because after capital assets have been allocated or placed, investments on such assets cannot be made null or return the company to its previous situation before the investment. With the real options approach, decision-makers apply the prerogative to delay the project up to a period when salient aspects of the uncertainty have been settled. This is usually applied through the breakdown of the plan in various successive stages with the implementation advancing as risks or uncertainties in one preceeding stage is addressed ( &  1999).             Another key concept is uncertainty, which pertains to the encompassing term covering situations involving unknown factors such as the future developments or the effects of the variables involved ( &  1999). Unknown does not necessarily mean that this is not discoverable. In the case of capital expenditures, certainty refers to the situation where the investor knows or has expectations on future investment returns so that uncertainty constitutes the collection of positive and negative values that could occur. Uncertainty is expressed in the price of fuel in the future that could increase or decrease giving a dual side to uncertainty.             Generally, there are two aspects of uncertainty, which are economic uncertainty and technical uncertainty. Economic uncertainty finds link with the general economic shifts in variables exogenous to the decision-making process because these are not significantly influenced by the business firm ( &  1994). Due to the exogenous nature of the shifting variables, the application of the real option approach is through the postponement of decision applications or cutting the plan into stages and awaiting positive changes in these economic variables. Technical uncertainty pertains to the unknown linked to shifts in variables endogenous to the business firm ( &  1994). This is exemplified by oil exploration venture. The certainty or uncertainty of unearthing oil is actually minimized through the actual investment on the oil exploration. Without this initial investment, the company will never be able to settle the issue of uncertainty. In this instance, real options approach applies through careful and step-by-step planning and examination of actual business context of the uncertainty.             Another key concept is flexibility, which refers to the capacity to abandon, defer, contract or expand investments every time that new information arrives on matters previously unknown to the decision-makers or on effects different from what was expected ( 1995). This applies to the case of the oil exploration. As the crew digs deeper into the earth and expenses mount, information is obtained over the probable or actual existence of oil so that depending upon the developing events decision-makers should be able to adjust to the situation by resulting to the pulling out of the team, transfer of site, or infusion of more funds. The soundness and viability of the decision and the adjustability of the decision-maker to changing conditions depends largely on the ability to weigh and analyse these changes ( 1996). Real option approach then urge decision-makers to develop a good perception of these changes in order to support adjustability.             Another key concept is contingency that pertains to the situation when future capital expenditures depend upon the viability of present expenditures ( 1996). This finds expression in the engagement of the firm to present investments even with negative NPV in order to build or realise value necessary to incur future returns. This is exemplified by a drug manufacturer that invests on research and development as well as testing in order to settle any problems with health value of the drug prior to actual marketing. Without incurring investments, the firm will never realise future returns from the mass marketing of the drug.                 The link between the successful application of contingency and real options approach is the intuitive character of decision-makers ( &  2000) that is necessary in knowing what, when, where, how and why to delay the completion of the capital expenditure plan until after the results of pilot studies have been analysed. Since the result of the pilot study or the completion of the investment is uncertain, decision-makers should be adept at contingent decision-making. Real options approach then supports contingent decision-making through its valuation paradigm that compares the measures derived for the capital investment decision with benchmarks or previous company and industry statistics.             The last key concept is volatility or instability of investment variables resulting to a range of probable outcomes depending upon the occurrence or intervention of certain variables. The degree of dispersion of these potential outcomes determines the degree of risk and uncertainty of the variable. ( &  1999) From an intuitive perspective, investments involving higher degrees of volatility translate to greater option value. In the traditional capital budgeting approach, greater volatility rates pertain to higher discount rates as well as low NPVs. The difference in perspective shows that real option approach enables decision-makers to consider even the unimaginable, which usually offers greater returns.             Real option approach then provides decision-makers with the option to delay or stagger the implementation of the capital budgeting plan even with a positive NPV value in order to maximize returns for the firm. By delaying implementation, greater areas of uncertainty are controlled ensuring greater returns for the company.             Overall, applying the real options approach develops intuitive decision-making in the case of capital budgeting that involves irreversible or long term consequences. On the surface this seems easy to accomplish with decision-makers relying upon their good business sense developed from experience in decision-making in the context of the firm, industry and economy. However, intuition is a cognitive process that is variable and relative. This means that even with guidance from previous experiences and industry trends, the decision would be difference for similar companies intending to engage in the same capital expenditure plan so that there would also be difference results. Nevertheless, there are also real option approach concepts that support this intuitive endeavour such as those discussed above applied in a continuous learning process that involves both failures and successes. Even if the process of mastering the intuitive decision-making through the application of the real options approach in capital budgeting is difficult, it is not impossible because of expected positive long term benefits to decision-makers and the business firm.   Applying the Real Options Approach in Capital Budgeting             Applying the real options approach in capital budgeting to achieve intuitive expertise involves the consideration of measures or benchmarks, the analyses of these measures, and then the development of contingencies for various expected scenarios and outcomes.             There are a number of measures available as measures necessary in capital budgeting. One measure determines the rate of return of investments. Real options approach modifies the NPV by considering only 0 or a positive value as the result. A modified NPV of 0 or a positive value means that the company has the option to push through with the plan, stagger the implementation, delay implementation, cancel implementation, and other options available to the decision-maker depending upon the context of the firm, industry and the overall business environment. ( 1996) Another measure covers uncertainty. Variance expressed through this symbol σ2 is a measure of the extent of uncertainty. However, since the derivation of information in the course of the delayed or staggered implementation of the plan involves time the variance measure becomes σ2 t. A higher resulting value indicates greater uncertainty while a lower value means otherwise. Moreover, variance can also be measured through standard deviation so that a higher standard deviation value means greater uncertainty and vice versa. ( &  1999) These measures are then considered in the valuation of different options by looking collectively at these factors: present value of operating assets; expenditures in asset acquisition involved in the capital expenditure plan; period of deferring the decision; value of money over the different time periods; and degree of risk integrated into the assets. From the information, the decision-maker then considers the various options and even with the selection of a particular option the exercise of the option is made flexible and subject to adjustments as new information is derived or changes occur in the plan. This means that while the measures provide a foundation for the decision, decision-makers still rely upon the rise of other options through time. Decision-makers then need to recognize these options and shifts in options, analyse these options in terms of the plan and the information derived, develop future scenarios and expectations, and move according to what is perceived as the most optimal action. Through the continuous engagement in these processes, decision-makers learn to spot changes, recognise the importance of options and flexibility, determine opportunities, and act flexibly decision makers end-up developing intuitive values. Ultimately, the continuous engagement in the difficult process of adopting real options approach to capital budgeting enhances the intuitive skills of decision-makers and brings in maximum benefits to the business firm.   Conclusion             Decision-making involving uncertain variables is difficult but doable. In the case of capital budgeting that involves irreversible impact of actions, decision-makers necessarily have to apply great care in deciding whether to push through or defer an investment plan. Real option approach supports decision-making through the consideration of a combination of measures as well as analytical skills on the part of decision-makers. This applies through the recognition of risk and integration of flexibility, volatility and contingency in the process. Although the decision-making process over uncertainty involves difficulties, it also results to long term benefits to decision-makers and the business firm. On the part of decision-makers, engagement in the process allows them to develop intuitive value through practical involvement in real options valuation and processing while on the part of the business firm intuitive value translates into maximised returns.    References   Credit:ivythesis.typepad.com

CORPORATE FINANCIAL STRATEGY

“The intuitions gained from the real options approach to capital budgeting are always useful, but the approach is very difficult, if not ...

Financial Markets and Financial Intermediaries

Financial Markets and Financial Intermediaries   Financial Markets                         Financial market makes buying and selling of financial securities, commodities, and other valuable items at low transaction costs and at prices that reflect efficient markets. Financial market is fundamentally an information-processing engine: it processes the orders that come in, it discovers a price, and it matches buyer and seller ( 2002 ). The global financial market has experienced a dramatic change since the early 1970’s (2004). Global forces for change included advances in information communication technology (ICT), making remote access to trading systems ubiquitous. The innovations in ICT and the development of new instruments in the financial market became self reinforcing. According to  (2004), other significant change agents were financial deregulation and liberalization at the national level, opening up to international competition, and globalization of financial and real markets. Additionally, changes in corporate behaviour, such as growing disintermediation and increased shareholder pressure for financial performance, were the prime movers behind the transformation in the financial services sector in the emerging market economies. Advancing globalization during the 1980s and the 1990s increased trans-border capital flows and tightened the links between financial markets in the emerging markets and global   financial centers. Growth of global financial markets was further accelerated by improvements in the fundamentals, particularly by more rapid economic growth in the emerging market and matured industrial economies.              (1999), argues that financial market play an important role in an economy because they bring together parties who have surplus or excess funds available for investment and those who have shortage of funds for investment, all of which makes for a more productive and efficient use of a country’s resources. Financial institutions act in the markets to combine the savings funds of many individuals into financial products to meet the investment needs of firms. According to  (2003), financial markets offer an efficient mechanism to channel savings for intangible investments. All financial markets have three dimensions: the creation of new credit, the trading of existing credit and the volume of accumulated credit.     Financial Intermediaries                         Financial Intermediaries are institutions, firms of individuals who perform intermediation between two or more parties in a financial context. According to the  (2006) the role of financial intermediaries as advisers, distributors, or broker-dealers is crucial, and in most cases, a vital link in the road to investment avenues. According to (2007), financial intermediaries are parties that help affect a transfer of funds from providers to demanders of capital. The transfer of funds can be direct or indirect. Example of financial intermediaries are brokers, credit-rating agencies, dealers, investment banks, insurance companies, pension funds, savings banks, closed and open ended mutual funds, private banks, venture capitalists, finance houses and commercial  banks. In performing their traditional roles, intermediaries gather savings deposited in small individual accounts and then lend out the funds in typically larger amounts – an activity sometimes called denomination intermediation (1998).  (2000) argues that financial intermediaries act as accountants of the economy and they implement the control function of money. Financial intermediaries are institutions that intermediate in the financial process between ultimate borrowers and ultimate lenders in the economy. The ultimate borrowers include consumers who need to borrow to finance part or all of their consumption, firms that borrow to invest in physical capital and government which borrows to finance its deficits. The ultimate lenders are the economic units that serve part of their current income by spending less that their current income on their purchases of commodities and want to lend some or all of these savings to others for some duration (2000). Financial intermediaries borrow from the ultimate lenders or from other intermediaries by issuing their own liabilities in exchange and re-lend to others by accepting the latter’s liabilities. In the modern economy, only a small proportion of the savings is directly transferred from the savers to the ultimate borrowers. Most of the savings are directed by the savers to financial intermediaries such as banks, mutual funds, pension funds, insurance companies etc., which re-channel the funds thus obtained to firms and the government, directly by buying their shares and bonds or indirectly through other financial intermediaries such as investment banks (2000). Since the inception of financial markets in industrial economies, savers have entrusted much of their wealth to intermediaries that, in turn, finance the projects of investors. Because of their importance, governments have long regulated the activities of these intermediaries to ensure sound financial markets (1995). Banks, savings and loans associations, credit unions, money market mutual funds, insurance companies, and brokerage firms are some of the most important financial intermediaries. Each of these business and, therefore, desires to make a profit. The profit arises from the fees the intermediaries charge and from the difference between the interest rate they pay on deposits and the interest rate they charge for loans. Financial intermediaries perform important functions that make financial markets work efficiently. Financial intermediaries provide important advantages to savers. Financial intermediaries also pool risk and create liquidity. Pooling risk means the funds provided by thousands are loaned to hundreds of individual firms. If a firm is unable to make its loan payments, that default is shared by all the depositors and no individual depositor is left with a high degree of risk. Liquidity means that an asset can be easily changed into cash (1990 ). (2003), argues that liquidity is the magic word of an exchange. Good liquidity attracts trading and new listings, poor liquidity repels them. Trade growth provides strong incentives for the growth of multinational corporations, which offer several advantages over simply exporting goods or services. Intermediaries use forward commitments to offer their clients a risk management service by guaranteeing the interest rate a client will pay on a loan. For example, if a forward commitment specifies a fixed interest rate, the issuing intermediary assumes the risk that rates might rise after giving the undertaking. The intermediary does not assume the interest rate risk if it only agrees to provide a line of credit at the market interest rate prevailing when the loan is actually drawn down, but competitive pressures might dictate prespecifying the rate. In this case, the intermediary may wish to hedge the risk in the futures markets (1998). In many cases, banks followed businesses into new markets with a view to protecting existing client connections. Once established, both the banks and the multinationals contributed to still more growth in international business, both financial and non-financial.               International banking activity can be divided into three principal types— offshore banking, arm’s length banking and host country banking. Offshore banking is like an assembly plant in a low wage country: it represents an economically advantageous means of carrying out the banking. Offshore banks thus carry out business for their domestic customers in a low cost jurisdiction. The jurisdiction’s tax laws are often the source of the cost advantages, but labor and other resource costs also play a role. Arm’s length banking is based on comparative advantage, and means that international banks can profitably make loans or investments which domestic banks are less qualified or too small to offer. As one example, US banks familiar with making relatively risky cash flow loans were able to do so profitably in small markets like Canada’s before an indigenous capability developed. To the extent this kind of activity occurs, the average costs of the international bank are lower than the average costs of the indigenous bank, principally because the international bank has a larger volume of business over which to spread the fixed costs of originally entering the business. Host country banking is full fledged foreign direct investment whereby banks accompany their countries’ investors to provide financing for the capital projects in the foreign country. Now, many of the world’s largest banks have full-fledged operations in a number of countries. These operations are largely international in character, but can also include retail operations in host countries (1998). Financial intermediaries are important because they can help in solving problems that transfer of funds from providers to demanders of capital entails.               Financial intermediaries avoid duplication and permit specialization. They serve to economize on search, evaluation and monitoring costs. Some of the desired change in asset quality through pooling and diversification are made possible by intermediaries. The issuance of senior, information-insensitive claims makes the intermediary the primary residual claimant to the quality of services it provides and diminishes the extent to which the intermediary needs to be evaluated by investors.       Characteristics and Developments of India’s Financial Market             The financial sector in India is consisted by commercial banks, non-bank financial institutions (NBFIs) and the capital market. India’s financial markets and financial intermediaries have two important characteristics: 1. The credit markets in India are highly segmented with commercial banks being the dominant players in the short-term credit market (credit for less than a year, mainly used to finance inventories), and NBFIs are the dominant players in the long-term credit market (mainly used to finance investments in plant and machinery). 2. Stock markets in India are relatively well developed compared with other developing countries.               According to  (2003), the evolution of the financial sector policies in India that started from 1969 can be divided into three distinct sub-periods: 1. Early 1970s – mid 1980s – a period of increasing financial repression 2. Late 1980s – 1991 – a period of mild reforms 3. From 1991 – a period of increasingly liberalized financial sector Commercial Banks             In the two decades since independence, banks in India operated in a relatively liberal environment. The nationalization of 14 banks in 1969 was a turning point in the evolution of banking sector policies in India. In 1991, as a part of the economic reform package, there was a considerable relaxation on the entry of new private banks and existing public sector banks were allowed to issue fresh capital to the public through the capital market. However, the ownership of the dominant commercial banks in the Indian financial sector remained in government hands. Mandatory requirements to invest in government securities and hold cash were scaled down drastically. This increased the ability of banks to lend, but there was very little change in the restrictive environment with regard to the deployment of credit; that is, there was no reduction in the priority sector lending requirements. With respect to regulations on the pricing of credit, most of the interest rate controls were lifted by 1994 in a gradual manner. The most significant change in the banking environment from the viewpoint of the private corporate sector was the interest rate deregulation. Banks were now allowed to charge differential interest rates for firms based on the risk perceptions, which was not the case prior to the deregulation. Lending decisions now rest with the banks themselves and political and administrative interventions have dramatically reduced. Non-Bank Financial Institutions             Non-bank financial institutions in India can be classified into three groups, namely the insurance sector, mutual funds and development finance institutions (also known as term lending institutions in India) (2003 ). Traditionally the Development Finance Institutions (DFIs) have been the most important source of long-term borrowings for private corporate firms. Financial liberalization has brought about three important changes to the operations of DFIs. DFIs have increasingly raised funds through the cpiatl market by issuing new shares, bonds, debentures and fixed deposits. The government permitted all DFIs to charge interest rates in accordance with the perceived risks inherent in the projects funded subject to a minimum lending rate in August 1991. With the abolition of industrial licensing and re-orientation of the economy away from planning industry specific capacity targets to markets driven allocation of resources, long-term credit provided by the DFIs is no more directed by the government. The DFIs are key financial intermediaries who would channelise investments based on market signals and as a result of their screening function. Capital Markets             Unlike other developing countries, India has had fairly well-developed stock markets and their role in the overall financial system has dramatically increased since the 1980s (2003 ). In 1992, there was a substantial deregulation of the stock market especially with the respect to the new issues market, with the abolition of the Office of the Controller of Capital Issues. Price controls on the issue of new shares were lifted and new guidelines that were less restrictive than those in the in the pre-1991 period were put in place. In September 1992, the Government of India allowed unrestricted entry in terms of volumes of investments in both primary and secondary markets to reputed Foreign Institutional Investors such as pension funds, mutual funds, investment trusts and asset management companies. Following these reforms, the three years from 1992 to 1995 saw a boom in the primary market.     Characteristics and Developments of China’s Financial Market             As the country moved away from a centrally planned economy, the Chinese financial structure was gradually reformed so that the needs of the economy could be satisfied. Between 1978 and 1984, various financial institutions were established. Since 1986, share-holding company-based commercial banks have been established at both national and regional levels. Non-bank financial institutions have also grown very fast. Investment trust companies, security firms, insurance companies, leasing companies, finance companies, and closed-end mutual funds have all been set up. In 1994, state owned commercial banks ceased to be required to carry out policy loans to state owned enterprises. China is a developing country as well as a transitional market economy. Financial development in China proceeds in a context that reflects both these long-term processes (2000). Although there are overshooting cases of market liberalization, China seems to remain in the category of compatible opening, if not over cautious (2003). Despite the negative impacts of market liberalization, these have been so far contained at a manageable level, as most economic, social and political problems have been mainly caused by domestic structural adjustment. China benefits a great deal from foreign investment, especially foreign direct investment. It has been the largest recipient developing country of foreign investment since 1993 (2003).     Credit:ivythesis.typepad.com

Financial Markets and Financial Intermediaries

Financial Markets and Financial Intermediaries Financial Markets Financial market makes buying and selling of ...

Undertaking Financial Planning

PART 1 1.    What net profit target should Julie aim for, based on the figures? Given: desired income ~ ,000                          initial investment ~ ,000 allowance for loan ~ ,000                      expected ROI ~ 9% growth fund ~ ,000                                  estimated tax liability ~ ,500   Julie expects an ROI of 9% from her ,000 equity capital, that is, ,700 annually. If that is the case, it totals to ,700 of after tax profit. Since she estimated her tax liability to be ,300, therefore Julie should aim for a net profit target of ,000. In figures:   = ,000 * 9% = ,700   = ,000 + ,000 + ,000 + ,700 = ,700   = ,700 + ,300 = ,000         Julie should aim for a net profit target of ,000.   2.    What gross profit margin percentage should Julie’s business earn? Accounting Fees       ,500 Advertising                  ,000 Cleaning                     ,400 Electricity                     ,800 Insurance                    ,200 Interest on loan          ,600 Rent                           ,000 Stationery                       0 Telephone                   ,000   Total Overhead Expenses            ,000                         To know the sales required in order for her to know the gross profit margin percentage:                         Overheads + Target net profit / Contribution margin %                                     = ,000 + ,000 / 47.5%                                     = 0,000 “ required dollar sales             Since gross profit is sales less cost of sales: let x = cost of sales                         4,000       = 0,000 – x                                     x          = 0,000 – 4,000                                     x          = 6,000             Using the formula for knowing the gross margin percentage:                                                             Gross profit $                                                             Sales $                                                 = 4,000 / 240,000 * 100                                                 = 47.5%                   Given that Julie’s research indicated that she could apply an average mark-up of 90% to the stock she purchases, the gross profit margin percentage that her business should earn is 47.5%.   3.    How much would Julie have to sell to break even?   Julie plans to apply a 90% mark-up to her stock, and from the table in the module, this mark-up should result in a 47.5% gross profit margin. It means that for every sales dollar, 52.5% goes to the cost of goods sold and the remaining 47.5% is left over to pay for the fixed costs. In figures:                                         ,000                                       $ 47.5%                 Which, reflected in the income statement would mean that:   Sales                                                  ,789.743              “         100% Less: Cost of sales                          ,789.743              “         52.5% Gross Profit                                              ,000               “         47.5% Less: Overhead expenses                    ,000 Net Profit                                                                          (break even point)   To illustrate more clearly, below is the break even chart for the above computation:                             Julie’s planned business would have to earn ,789.47 in order to break even with the costs for purchasing the products.   4.    What sales target should aim for if she wishes to cover all of her costs and earning the net profit calculated in Question 1?   As with Question 2, the computation for the sales target is as follows: Since gross profit is sales less cost of sales: let x = cost of sales                         4,000       = 0,000 – x                                     x          = 0,000 – 4,000                                     x          = 6,000   Ultimately, using the previous solutions, the variable costs could be arrived at in order to cover all the costs that Julie has projected while at the same time earning the net profit of ,000 calculated in Question 1.   Sales                                                              0,000             Less: Variable Costs                                   6,000             Gross Profit                                                   4,000             Less: Fixed Costs                                        ,000             Profit                                                               ,000   5.    Draw up a Projected Profit Statement for Julie’s business. >> in the attached spreadsheet <<     6.    Set a new sales target using the following sales mix. <ul style="margin-top: 0in; margin-bottom: 0in" type="square"> <li class="MsoNormal" style="text-align: justify; line-height: 200%"> Product A (150% mark-up) ~ represents 50% of sales.</li> <li class="MsoNormal" style="text-align: justify; line-height: 200%"> Product B (100% mark-up) ~ represents 25% of sales.</li> <li class="MsoNormal" style="text-align: justify; line-height: 200%"> Product C (50% mark-up) ~ represents 25% of sales.</li> </ul> PRODUCT A 6,000 * 50% = ,000 * ,000 is the cost of sales for Product A ,000 * 150% = 0,500 *0,500 is the total sales for Product A   PRODUCT B 6,000 * 25% = ,500 *,500 is the cost of sales for Product B ,500 * 100% = ,000 *,000 is the total sales for Product B   PRODUCT C 6,000 * 25% = ,500 *,500 is the cost of sales for Product C ,500 * 50% = ,250 *,250 is the total sales for Product C Thus:          Product A                        – 0,500 Product B                        –   ,000 Product C                        –   ,250                                 0,750   LINE               ESTIMATED VALUE          MARGIN %                   ESTIMATED                             OF SALES ($)                                                      GROSS PROFIT    A                           ,000                60%                               ,800    B                           ,500                50%                               ,750    C                           ,500                33.3%                            ,489.5                                 6,000                                                                ,039.5             The average margin for the whole business is thus:             Margin %       = ,039.5 / 6,000 * 100                                     = .50825 * 100             Margin %       = 50.825 or 50.85%             Julie aims for a gross profit margin of 47.5%, which is less than the above amount which resulted from the new sales mix. This means that the pricing formula provided in Question 6 is acceptable.       Using the new gross profit percentages provided and the cost of sales figure from the projected profit statement in Question 5, the new sales target using the said sales mix is 0,750. PART 2 1.    If she purchases the non-current assets she needs for her business, what amount will she need to set aside?   NON-CURRENT ASSETS (NCA)             Shelving and display cases           ,000             Cash register                                                  ,000             Desk and chair                                      0             Computer                                             00 TOTAL COST OF NCA                               ,000       Julie needs to set aside ,000 for the non-current assets that she plans on purchasing.   2.    Calculate how much Julie should allow for start-up costs.   STARTUP COSTS             Business name registration              0             Promotional advertising                 ,500             Legal fees                                            0             Utilities connection                             0             Prepaid rent                                      ,000 TOTAL STARTUP COST                            ,200       Julie should allow ,200 for start-up costs. 3.    Calculate the total capital Julie will require.   For Julie’s Jools, it was assumed that she will need non-current assets of ,000 and her list of start-up costs total ,200. Since these figures are exclusive of GST, the total capital requirement including an allowance for GST will be:                     Non-current assets                          ,000                   Start-up costs                                      ,200                   Working capital                                ,050*                                                                               ,250                   Add: 10% allowance for GST           ,670                   Total Capital Required                    ,875                  * Working capital is the initial set-up of core stock plus the prepaid rent plus the fund allotted for growth plus prepaid loans minus the ,000 trade credit that she has managed to obtain from her suppliers, which in figures, would be:                   Cost of sales / 12 months                               = 6,000 / 12 months                               = ,500                                                                         ,500 * 3 months = ,500 “ initial stock                                                            ,000 “ prepaid rent                                                            ,000 “ fund allotted for growth                                                            ,000 “ allotted for loan payment                   Total current assets = ,500                                                            ,550 “ additional 10% cash buffer                                                          ,050                                                          ,000 “ less trade credit limit                                                          ,050       Total capital required of the business will be ,875.   4.    If Julie invests her total redundancy package of ,000, how much will she need to borrow?                                                                         = ,875 – ,000                                     = ,875       From the total capital required of the business, which is ,370 and from her total redundancy package of ,000, she would need to borrow ,875 from creditors to start running her business.       5.    What type of funds do you think Julie should access to set up her business?   Julie has already managed to obtain a ,000 trade credit limit from her suppliers so there is only the need to look for additional sources of fund. A line credit would be useful for acquisition of part of the working capital, as they may offer a lower rate than a business overdraft and present greater flexibility than all the other sources of fund. However, as mentioned in the module, there is the need to exercise discipline and control in the withdrawal of credit, as the business may end up paying for only the interests accrued and not the line of credit in itself. And because lines of credit are available through a number of easily accessible financial institutions, such as banks, Julie would do well to adopt the line of credit as one of the source of fund for her working capital. Commercial loan financing, particularly lending involving banks and similar financial institutions, is invariably one of the important components of any firm’s capital structure. In many cases, the first funding that the business receives will come from a commercial bank which is induced to provide a loan on the basis of the firm’s business and financial plans and the guarantees of one or more of the founders and/or their associates. As the firm grows, its commercial lending relationships will become increasingly important, and the business may find itself using a wide range of lending tools on varying terms and with repayment dates that may range from a few months to several years in the future. Government loan programs may also provide a good source of financing for the business. In most cases, the loan terms offered under these government programs are essentially similar to those that might be offered by private commercial lenders; however, it may be that a government loan will be available to a firm that might not otherwise qualify for a commercial loan at that particular stage of its business. If at all possible, Julie should make an attempt to acquaint herself with the resources of the federal and state business development offices in her area. Term loans can be applied to the ,000 purchase of non-current assets of her business, and since it allows Julie to plan for her cash flow, it is one of the more ideal types of fund that exists for business financing these days. Although many businesses are started with venture capital funding, in many cases the initial capital is provided by private lenders, including the founders of the business and their friends and associates. Private debt financing is generally short term in nature, which would serve the end of Julie’s plans, as she wants to pay off her debts in the earliest time possible. It additionally may be accompanied by some form of equity investment or the right to purchase equity securities in the future. Depending upon the circumstances, the documentation associated with private lending may be minimal, with the parties relying on the delivery of a simple promissory note containing the principal amount of the loan, the terms of any interest payment obligations and the due date upon which the loan is to be repaid. In raising funds from private lenders, Julie needs to be sure that she does not unduly impair the ability of the company to secure funding from venture capitalists, banks and other more sophisticated investors. In many cases, it will be expected that the private debt will be repaid upon completion of a subsequent venture capital financing or that the outstanding amount of any indebtedness will be converted into the security that is to be issued to the new investors on the same terms and conditions. A private lender may request the opportunity to serve on the board of directors of the company; however, any agreement on this matter should be made subject to further amendment in order to satisfy the requirements of any new investors. 6.    List the factors Julie should take into account when comparing different financial products to ensure she secures finance on optimal term.   There are many basic considerations relative to the comparison of different financial products to ensure money to start the business. Knowledge of the legal and business issues that continuously arise in the course of obtaining capital to operate the business should therefore be known to Julie, or anyone who wishes to start a business, for that matter. Interest rate, fees and charges, the option to lease, borrow or buy, and the choice of finance brokers are already mentioned in the module so the next paragraphs will focus on the other considerations that need to be taken into account when comparing different financial products to ensure that Julie secures her funds on optimal terms. Funding can be provided for a variety of different terms or durations. For example, equity financing is generally permanent, unless the company has an obligation to redeem the security at same date in the future. However, in commercial loan, as well as debt financing from private investors, is provided on a fixed-term basis and must be repaid at some time in the future. Loans may be made on a demand basis, in which case they must be repaid at any time that the lender makes a demand for repayment, on a short-term basis, which generally is considered to be for a term of no more than one year, or on a long-term basis, which means that the loan must be repaid on some date outside of a year from funding. It is important for the managers to fix the funding duration in a manner that conforms to the anticipated business cycle and needs of the business. Every type of funding, including commercial loans, involves a degree of risk capital. Julie should assume some degree of risk that the capital provided to the business will not be repaid or that she will not realize the anticipated return on the investment of funds. It can be anticipated that Julie will seek some security for the risks assumed in advancing the capital, and she must be cognizant of the effect that any sort of protection might have upon the operations of the business, the interests of the shareholders, and the ability of the business to attract additional funding. The amount of risk managers are comfortable with is likely to have a large bearing on the debt position of the firm, particularly for small firm owner/managers, who often must personally guarantee a loan in order to procure one. Their financial risk propensity would thus seem to directly affect the capital structure of the small firm. The risk propensity of the owner and financial characteristics of the firm affect the amount of debt lenders are willing to offer and on what terms. This thus states that Julie’s aversion to risk and the financial characteristics of her business suggest different levels of risk of default to lenders. Therefore, the amount of funds they are willing to lend or invest may affect the maximum debt level a firm can achieve, as well as the cost of that debt. The above reflects the external perspective most prominent in corporate financial theory. As for the private lending, there is a legal consideration. Private loans are generally evidenced by a promissory note executed by the borrower in favor of the lender which contains a promise by the borrower to repay the borrowed funds together with interest at the time or times specified in the note. The note usually does not contain all of the various agreements between the parties regarding the loan. Instead, the parties may enter into a separate loan agreement which sets forth representations and warranties from the borrower to the lender, certain covenants to be honored by the borrower, and any events of default that may give the lender the right to accelerate payment of the loan. So long as the promissory note is retained by the original lender, the borrower will be entitled to all of the benefits that have been provided to it under the terms of any separate loan agreement. However, if the note is a “negotiable instrument” and is transferred to a third party who is deemed to be a “holder in due course,” the third party will have the right to enforce the payment terms of the note even though the borrower might have a valid defense against the lender under the loan agreement which would entitle the borrower to delay payment. Loans, on the other hand, may be made on the basis of the raw material, work-in-process, or finished goods inventory of a business. As with accounts receivable financing, the maximum amount a borrower may borrow is fixed as a percentage of the cost or market value of its eligible inventory. However, since inventory is far more difficult to value, and less liquid, than account receivables, the maximum percentage of inventory value that a lender is willing to advance is generally much lower than with accounts receivable financing. This should also be considered as an avenue by Julie so that she should be open to the possibilities that her fund sources are offering her. PART 3             Total Capital Required ~ ,875             Fund Sources:                         Redundancy package        ~ ,000                         Loan capital                          ~ ,875                         Trade Credit                          ~ ,000                         Term Loan                             ~ ,000                         Private Lending                    ~ ,000                                                                            ,875               Since Julie allowed for a 90% mark up to the cost price of her jewelry, and the table in the module shows that this will result in a gross profit margin of 47.5%, this means that if she sells 0,000 worth in a year, she will make an annual gross profit of 4,000 if the 6,000 amount of the cost of sales will be deducted. Thus, the cost of sales percentage is at 52.5%. Shown in a table:                         Sales                                                  0,000       “ 100%                         Less: Cost of sales                          6,000       “ 52.5%                         Gross Profit                                       4,000       “ 47.5%               From all the workings on this paper, I can say that the financial plan for Jule’s Jools is viable because the projected income statement has reflected a net profit which, an amount which is not bad for a starting business. The projected sales are also very minimal, as they can be raised up by 10% per month of operation, with what the demand for sterling silver jewelry nowadays, which have become the replacement for gold jewelry. The financial plan can be further improved though. The mark-up of 90% could be raised up to 110%, since it is the normal mark-up of jewelry business nowadays. This would result in an increase in the gross profit of the business, which will ultimately have an effect on the net profit. The allowance for tax liability is somewhat small, too, considering the examples presented in the module, which showed that a profit of ,000 is allotted a ,000 amount for its tax liability. The trade credit limit could be negotiated to increase up to ,000, and if the owner knows financing institutions who offer lower interest rates and longer duration for payments, then so much the better.           Credit:ivythesis.typepad.com

Undertaking Financial Planning

PART 1 1. What net profit target should Julie aim for, based on the figures? Given: desired income ~ ,000 ...